Oil drifts while waiting for supply build confirmation

Oil prices are drifting lower ahead of this morning’s EIA oil inventory report and after the API reported a much larger than expected build in crude oil but partially offset by a larger than expected draw in gasoline stocks. At the moment the market is mostly focused on the potential of the surplus of crude oil in the U.S. starting to once again increase. In addition the market is still digesting the impact the shutdown the Pegasus pipeline may have on the supply and demand balances in the Midwest and U.S. Gulf Coast as well as in Canada.

The externals have been mixed with U.S. equities hitting yet another new all-time high and thus very supportive for oil and the broader commodity complex while equity markets in other locations did not fare as well sending a mixed signal for the macro traders. The currency markets were also sending mixed signals with the euro settling into a trading range while the U.S. Dollar Index seems to be struggling to remain at the current high levels. The U.S. Dollar Index has been in a strong uptrend since bottoming in early February. A rising U.S. dollar is generally a negative for oil and the broader commodity complex.

In Asia the latest data released showed that China’s services industries grew strongly in February suggesting that the main economic growth engine of the world may be starting to pick up steam. That said the services sector is a very important part of the Chinese economy but China’s economy remains mostly driven by the manufacturing sector which supports its extensive global export business. In addition, it is the manufacturing sector that is primarily responsible for the growth rates in oil consumption.

Once again China is calling out Japan on the declining yen and the possibility that it could result in other Asian countries weakening their currencies to stay competitive in the export market. These comments are coming at a time when Japan is looking to increase the magnitude of their quantitative easing program, which will likely result in the yen declining even further from current levels.

The yen has already declined about 8% for the year-to-date putting Japan’s export oriented economy in a much more competitive position then it was in just last year. All of the G-20 leaders officially acknowledge that there is not a currency war nor an exposure to one. That said the comments coming from the other major export oriented economies in Asia are certainly sounding the alarm.

Global equities have continued to send a mixed picture as shown in the EMI Global Equity Index table below. The Index has continued to lose ground on the week declining by about 0.5% over the last twenty four hours even as the US Dow hit another new all-time record high. The rally in equity markets is not a global rally rather a selective rally in some markets. The U.S. has been strong based on the view that the U.S. economy is still continuing to grow. Japan’s bourses have remained strong all year on the weakening yen, which is a strong positive for this export oriented economy. On the other hand, Brazil has continued to weaken as the government fights inflation and growth issues. On a macro basis the global equity market is a negative price driver for oil, however, on a selected equity market basis there are signs of support coming from places like the U.S.

On the fundamental side of the equation, the shut-down of the Pegasus pipeline in the U.S. Midwest is still the main story line. The pipeline was shut last Friday afternoon and has remained down since then. Reports indicate that about 4,000 barrels of heavy Canadian oil has leaked. If those reports of the size of the leak are accurate it suggests to me that leak should be able to be fixed relatively quickly. However, even if the break is repaired quickly it does not mean the line will be started very quickly as the authorities are likely to place new restriction on Exxon before giving permission to restart operations. For example the U.S. Pipeline and Hazardous Materials Safety Administration issued an order yesterday citing hazards to life, property and the environment if the pipeline were to continue operating without corrective measures. Exxon indicated they are studying the order but did not offer any further comments on what actions will need to be taken.

The short term direction of the Brent/WTI spread as well as many other crude oil relative relationships from Canadian crudes all the way down to the crude consumed on the U.S. Gulf Coast will be dependent on how long this line remains down. Many of the spreads initially widened strongly on Monday and into Tuesday (Brent/WTI spread for example) only to retrace modestly by the end of yesterday’s trading session. At the moment there is no word from Exxon on when they are anticipating a restart. Certainly the longer the line remains down, the greater the potential for oil backing up in the Midwest as well as in Canada.

Tuesday's API report was bearish for crude oil but supportive for refined products. There was a surprisingly larger than expected build in crude oil stocks (for the second week in a row) but offset by a larger than expected draw in gasoline and distillate fuel inventories. Total crude oil stocks increased by 4.7 million barrels versus an expectation for a smaller build. Gasoline showed a draw in inventory as did distillate fuel stocks. The API reported a 4.7 million barrel draw in crude oil stocks versus an industry expectation for a modest build of around 2 million barrels as crude oil imports increased modestly while refinery run rates also increased by 0.9%. The API reported a modest draw in distillate fuel inventories and in large decline in gasoline stocks.

The API report was mixed. The entire oil complex is in negative territory so far this morning heading into the EIA oil inventory report to be released at 10:30 AM EST today. The market is usually cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning. The API reported PADD 2 stocks built by around 815,000 barrels while Cushing stock decreased by 0.3 million barrels. On the week gasoline stocks decreased by about 5 million barrels while distillate fuel stocks decreased by about 1.9 million barrels.

My projections for this week’s inventory report are summarized in the following table. I am expecting a modest build in crude oil inventories, a modest decline in distillate fuel... as the weather was winter-like over the east coast... and a small draw in gasoline stocks during the report period as refinery runs remain at below normal levels during the maintenance season.

I am expecting crude oil stocks to increase by about 2 million barrels. If the actual numbers are in sync with my projections the year over year comparison for crude oil will now show a surplus of 22.7 million barrels while the overhang versus the five year average for the same week will come in around 36.7 million barrels.

I am expecting a modest build in crude oil stocks in Cushing, Ok and in PADD 2 as the Seaway pipeline has been has been running at constrained levels for most of the report period. The impact of the Pegasus pipeline shut down will not impact this week’s report as the line was shut on Friday afternoon or after the EIA inventory snapshot. It will impact next week’s report and likely result in another build in crude oil in the region. This will be bullish for the Brent/WTI spread and will serve as a catalyst to keep the short covering rally going.

With refinery runs expected to increase by 0.2% I am expecting a draw in gasoline stocks. Gasoline stocks are expected to decrease by 0.5 million barrels which would result in the gasoline year over year returning to a surplus of around 3.1 million barrels while the surplus versus the five year average for the same week will widen to around 1.6 million barrels.

Distillate fuel is projected to decrease by 1 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 17.6 million barrels below last year while the deficit versus the five year average will come in around 21.3 million barrels.

The following table compares my projections for this week's report (for the categories I am making projections with the change in inventories for the same period last year. As you can see from the table last year's inventories are in directional sync but with some large differences compared to last year’s changes. As such if the actual data is in line with the projections there will be large changes in the year over year inventory comparisons for most everything in the complex.

I am maintaining my view of the entire complex at neutral but with a cautiously bullish bias as the oil complex appears to have formed a short term technical bottom. HO and RBOB have been trending higher but within the confines of a trading range. They are both currently trading near the upper end of their respective trading ranges. WTI has now breached its range resistance level with Brent hovering very near its range breakout level. The complex is showing signs that the next move could be a move to the upside.

I am maintaining my view at neutral for Nat Gas as the forecasted weather pattern still appears to be a negative for heating related Nat Gas demand. I do not expect prices to collapse but I view the moderating temperatures to result in the Nat Gas price rally likely topping out at this time as the lower demand shoulder season finally arrives.

Markets are mostly lower ahead of the U.S. trading session as shown in the following table.